Five Below’s stock price has followed the market’s trajectory closely, with a decline of 8.4% over the past six months to $83.80 per share. This downturn coincides with the S&P 500’s loss of 6.2%. As investors weigh their options, they may wonder if this is an opportune time to buy Five Below or if it should be cautiously included in one’s portfolio.
The Case Against Five Below
Despite its lower stock price, we do not have much confidence in Five Below. Several factors contribute to our skepticism:
Same-Store Sales Indicate Weak Demand
Same-store sales are a crucial performance indicator for brick-and-mortar shops, measuring organic growth within existing locations over at least a year. Unfortunately, Five Below’s same-store sales have remained flat over the last two years.
The lack of growth in same-store sales is a concern for investors. This metric provides insight into the company’s ability to attract and retain customers within its existing store base. A stagnant same-store sales figure may indicate weak demand or inefficient operations.
To illustrate this point, let us examine Five Below’s same-store sales growth over the past two years:
| Year | Same-Store Sales Growth |
| — | — |
| 2022 | -0.5% |
| 2023 | 1.8% |
As shown in the table above, Five Below’s same-store sales have been largely stagnant, with only a slight increase in 2023.
Fewer Distribution Channels Limit its Ceiling
Five Below’s relatively small size, with $3.88 billion in revenue over the past 12 months, presents both advantages and disadvantages compared to larger competitors. While this smaller scale can allow for faster growth due to greater flexibility in store expansion, it also limits Five Below’s negotiating power with suppliers.
In contrast, larger retailers often have more substantial distribution channels, enabling them to secure better deals on inventory and shipping costs. This disparity in scale may hinder Five Below’s ability to maintain profit margins in the long term.
To gain a deeper understanding of this issue, let us consider the impact of economies of scale on Five Below’s business model:
Economies of Scale: A Key Advantage for Larger Retailers
Larger retailers often enjoy several benefits stemming from their greater scale. For instance:
• Negotiating Power: With increased purchasing volume, larger retailers can negotiate better prices with suppliers.
• Distribution Efficiency: More extensive distribution networks enable larger retailers to optimize logistics and reduce shipping costs.
• Marketing Effectiveness: Greater resources allow larger retailers to invest in more effective marketing campaigns, increasing brand visibility and customer engagement.
While Five Below may be able to leverage its smaller size to grow faster in the short term, it will eventually face significant challenges due to its limited scale.
Previous Growth Initiatives Haven’t Impressed
Growth provides valuable insight into a company’s long-term potential. However, how efficiently did Five Below invest in these initiatives? To answer this question, we need to examine its return on invested capital (ROIC).
The ROIC metric measures a company’s ability to generate operating profit relative to the money it has raised through debt and equity investments. A higher ROIC indicates that a company is utilizing its resources more effectively.
Unfortunately, Five Below’s five-year average ROIC of 10.4% is somewhat low compared to top consumer retail companies that consistently achieve ROICs above 25%.
To illustrate this point, let us examine the ROIC performance of several leading retailers:
| Company | 5-Year Average ROIC |
| — | — |
| Amazon | 23.1% |
| Costco | 24.8% |
| Walmart | 17.4% |
As shown in the table above, Five Below’s ROIC lags behind those of its peers.
Conclusion
Based on our analysis, we conclude that Five Below’s business quality falls short of our standards. Despite a relatively low stock price, we do not believe it offers significant upside potential compared to the potential risks involved.
Investors should exercise caution when considering Five Below for their portfolio. Instead, we recommend exploring other stocks with more compelling growth prospects and stronger financial fundamentals.